New RBI policy will structurally strengthen ARCs, says CRISIL report

18 Oct 2022 , 08:11 AM

In addition to strengthening them structurally with better governance, better disclosures, fewer funding requirements for asset acquisitions, and robust balance sheets, the new regulatory guidelines for asset reconstruction companies (ARCs) will cause consolidation in the industry, according to a report.

Crisil Ratings’ analysis indicates that the new requirements for ARCs, which were announced by the Reserve Bank last Tuesday, will require them to increase their net-owned funds by three times, to Rs300 crore from Rs100 crore, in a phased manner by March 2026. This could be difficult for smaller ARCs.

However, two significant improvements in the legal framework–lower capital requirements for asset acquisitions and two–an opportunity to participate as a resolution applicant under the bankruptcy code–will favourably affect the business profiles of ARCs.

According to the new regulations, ARC investments in security receipts (SRs) must be at least 15% of the SR transferor’s investment or 2.5% of the total number of SRs issued, whichever is higher, in each asset class and for each scheme on an ongoing basis until SRs are redeemed.

Before, even in the presence of investors other than the selling lenders, ARCs might invest at least 15% of the SRs issued in each class under each scheme.

The agency anticipates the momentum to continue with decreasing funding needs for cash-based transactions. It should be mentioned that the percentage of cash-based transactions in SRs has been rising gradually and reached at 36% in February 2022 compared to 4-5% in February 2017.

The organization views RBI’s decision to let ARCs participate as resolution applicants in the IBC process as a positive step because it will increase available business opportunities and possibly create a new source of income. However, only a select number of the 28 ARCs may be able to gather the net-owned funds of over Rs1,000 crore required to be a resolution applicant.

The regulator has also put in place a number of steps to strengthen the governance structure of ARCs, including increasing the independence of their boards, limiting the length of board member terms, and creating a process for board members to be evaluated on their performance.

According to the paper, having stricter disclosure requirements for financial data, a track record of returns produced, and recovery ratings on SRs in offer documents is projected to increase transparency and, as a result, investor interest in ARCs.

The rules limiting management fees to money recovered through the sale of underlying assets should motivate ARCs to prioritize expedited settlement.

Many of the ARCs may not be able to raise more capital because more than half of them have net-owned funds that are less than the revised criterion of Rs300 crore.

Additionally, new governance initiatives will probably raise compliance and operational costs, which could be difficult for smaller ARCs and eventually result in consolidation.

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